What Canadians Need to Know about Tax Planning for Investing in U.S. Real Property

Posted by Kim Chen on January 15th, 2014

It is a growing trend that more and more Canadians are purchasing second homes in Southwest Florida. They are motivated by bargain prices, the strength of their dollar, and the beach and sunshine in Southwest Florida. The acquisition of U.S. real estate by a Canadian poses significant issues including, but not limited to, U.S. estate tax, capital gains tax, complex Florida probate rules and creditor protection issues. There is no simple answer and one size does not fit all.

Estate taxes are of paramount concern when Canadians own property in the U.S. The general rule is that a foreign person may only pass $60,000 of U.S. assets to their spouse or other beneficiaries free from U.S. estate tax. The U.S. imposes a tax of 45% on assets that are situated in the U.S. with value in excess of $60,000. The estate of every foreign person is required to file a U.S. Estate Tax Return if the property they own is worth over $60,000, even if there is no estate tax payable.

Fortunately, the U.S.-Canada Estate Tax Treaty allows Canadians the same current $5.25 million exemption from estate tax that is available to U.S. citizens and residents. However, this exemption is applied to a Canadian person’s worldwide assets. This means that if worldwide assets are worth less than $5.25 million, a Canadian will not be subject to U.S. estate tax upon their death. On the other hand, if worldwide assets are greater than this amount, then the exemption is pro-rated between U.S. assets and worldwide assets. If the pro-rated exemption should happen to be less than $60,000, the decedent can still make use of the flat $60,000 U.S. exemption allowed to all non-residents.

Canadians often use their U.S. real property to produce rental income when they are not present in the U.S. When this occurs, the rental income is required to be reported on both a U.S. and a Canadian tax return. Canada does allow a foreign tax credit for any tax paid to the U.S. on this rental income so that double taxation can be avoided.

Canadians have several ownership options available when buying real estate in the U.S. A brief summary of the consequences of different forms of ownership follows:

1. Title to real estate is placed directly in the individual(s) name(s). This is a simple approach often used in Florida. However, it does raise the following concerns:

a. Probate – Although a valid Canadian will is recognized by Florida law, it may still be an expensive and time consuming probate process to transfer title in Florida.

b. Incapacity – If the property owner becomes mentally incapacitated, it can be a lengthy and costly process to obtain Florida guardianship.

c. Creditor Protection – Third party creditors can place a lien or even attempt to foreclose on the property.

d. Estate Tax – Planning must be done to avoid U.S. estate tax concerns as discussed above.

2. Title to the property is acquired by a Canadian corporation. This method can be used to avoid U.S. nonresident estate tax problems. However, it usually results in higher income taxes on the ultimate sale of the property if sold at a gain and brings additional administration costs and other complications. Additionally, a taxable shareholder benefit may result if the property held by a corporation was made available for the personal use of the shareholder.

3. Title to the property is acquired by a Canadian Trust. This method, too, can avoid US nonresident estate tax problems. However, the trust must be set up before the purchase of the U.S. property and the person who provides the funds to the trust for the purchase must not be a trustee or a beneficiary of the trust. Additionally, where an individual creates such a Trust for their spouse, if the grantor’s spouse predeceases the grantor, the grantor must pay fair market value rent to the trust for future use of the property in order for the property to be excluded from his or her estate for US estate tax purposes. This approach may also result in higher income taxes and more administration costs.

4. Title to the property is acquired by a U.S. Limited Liability Company. This approach should most likely be avoided by Canadians. An LLC may be treated as a corporation for Canadian income tax purposes notwithstanding the U.S income tax treatment of the LLC. Because the LLC’s members, including its Canadian members, would also be subject to U.S. taxation on the LLC’s income, the Canadian tax imposed on the LLC (remember Canada views the LLC as a corporation) would result in a second level of taxation. The treaty would not protect the LLC from Canadian taxation on its worldwide income since Canada does not grant treaty benefits to the LLC. Thus, a Canadian member who earns income through an LLC cannot claim the treaty benefit. Hence, using the LLC will expose the Canadian to significant double taxation.

5. Title to the property is acquired by a U.S. Corporation which is owned by a Canadian Corporation. This method can be used to avoid U.S. estate tax and to provide asset protection but it will involve higher taxes, more costs, and more complexity.

6. Title to the property is acquired by a U.S. Limited Liability Partnership. While this method is favored for asset protection purposes, it does not avoid U.S. estate tax. Additionally, it requires the filing of both a U.S. Partnership return as well as U.S. Income tax returns by each of the partners. This method does avoid the potential double taxation of a corporate structure but it, too, can be costly and complex.

As you can see, it is very important for Canadians to understand the various tax issues before contemplating and structuring a U.S. real estate acquisition. We would be very happy to help you analyze your options. Please contact our office for a tax consultation.

CIRCULAR 230 DISCLOSURE – To ensure compliance with requirements imposed by the IRS, unless specifically indicated otherwise, any tax advice contained in this communication (or in any attachment) was not intended or written to be used, and cannot be used, for the purpose of (1) avoiding tax related penalties or (2) promoting, marketing or recommending to another party any tax related transaction or matter addressed in this communication.